Asset & Wealth Management Revolution:

The AWM industry is a digital laggard. Firms should tap technology to create a single state-of-the-art platform to help them from front to back. Companies with siloed teams, limited automated advice capabilities and an insufficient understanding of the broadening role of technology will fall behind. 

The AWM industry continues to play a vital role in filling financing gaps. Managers are becoming more involved in various new, and in some instances more available, asset classes, including peer-to-peer lending, trade finance and infrastructure financing. As a decline in defined benefit plans drives growth in defined contribution plans, the pursuit of alternative products is creating significant market demand.

Actives, passives, smart beta and alternatives are becoming building blocks for multi-asset, outcome-driven strategies. Large firms are creating multi-asset strategies, while small and midsized firms are acting as suppliers of the building blocks. The multifaceted nature of this changing marketplace creates opportunities for firms of all sizes and investment styles – as long as the focus is on delivering consistent, superior investment returns. 

Active players’ management fees will decline by 19.3%, reaching 0.44% in 2025. However, the pace will differ vastly across regions. The drop will be slowest in the US – where fees are already at the lowest levels globally – and fastest in Europe, with prices for active mutual funds expected to fall by 26.0% between 2017 and 2025. This steep decline is anticipated as the Markets in Financial Instruments Directive II (MiFID II) becomes more entrenched, investor scrutiny grows, and the shift to low-fee products continues. We’ve already seen the effect of regulation on prices in the UK, where the introduction of the Retail Distribution Review (RDR) caused active management fees to fall by 25% between 2012 and 2017.

It is important that investors understand headline fee rates and where this fee is earned. New transparency has revealed that a significant proportion of current management fees is paid to intermediaries that have a direct relationship with end clients. This is particularly prevalent in Europe and Asia. The introduction of MiFID II and the move towards more direct-toclient channels will probably cause fees for intermediaries to decline.

In the US, high cost structure and inadequate technology, along with shifting product preferences, are confronting the traditional broker model. Independent brokers with low-cost operating models, open-architecture investment platforms and up-to-date technology are seeing strong growth, as are registered investment advisers that are technologically enabled and more focused on model portfolios than on single products.

We believe Asia-Pacific will also see a steep fee drop, with average asset-weighted management fees decreasing by 24.6% between 2017 and 2025, to reach 0.43%. Asia-Pacific is dominated by price-sensitive institutional investors and high-net-worth individuals, whose demand for more from their asset managers at lower cost will drive this decline. Lower prices are also one of the leading drivers of the consolidation that the Asia-Pacific market is experiencing. Additionally, the prevalence of low-fee products such as money market funds and exchange-traded funds (ETFs) in retail-driven markets, such as China and Japan, is driving fees lower. 

Passive funds continue to see strong inflows, buoyed by record equity market performance. Institutional investors are surging to passives, in part because these products offer transparency and low fees. In recent years, North American and Western European retail investors have begun to increase allocation to the passive market, particularly in the rapidly growing area of defined contribution. We anticipate this trend will continue around the globe. Rising demand for passives has intensified competition among all players, including active, alternative and traditional long-only.

Amid intense competition and minimal differentiation capabilities, we believe that by 2025 management fees on all passive asset classes will decline by 20% or more from their already low level. Our forecasts show that between 2017 and 2025, average global asset-weighted passive fees will drop by 20.7%, to reach 0.12%. Given low margins in passives, scale is key and large players will find it far easier to operate profitably. Price remains the key differentiating factor among traditional passive products. 

The passive ‘race to zero’ has long been a topic of discussion in the AWM industry. But the finish line has never been closer. One mega-manager’s recent launch of two index-tracking funds with zero fees shocked the industry. Some public firms’ shares fell within hours of the announcement, even though this wasn’t the first time that passive managers have dropped fees to zero. Leaders of the pack have previously used the strategy to attract assets and scare away competition. We believe that this development will reshape the entire passive landscape, as more competitors will need to follow suit or risk losing investors.

Other large passive asset managers have already started to take action: some have slashed prices multiple times this year, and others launched ETF platforms with no transaction fees. But it’s unlikely we’ll see all passive funds move to zero. Instead, managers may use zero fees on select funds to cross-sell other alpha-focused products and ancillary services. We have already seen more recent entrants into the passive industry focus on smart beta or active strategies in an ETF wrapper to differentiate their offering and protect fees. 

Global alternatives AuM grew 67.3% between 2012 and 2017 and is set to reach US$21.1tn by 2025 because of continued institutional investor interest and increasing retail investor interest in this segment. The often-talked-about alternatives fee model of 2/20 has become more elusive since the global financial crisis ten years ago. Within hedge funds, for example, 40% of all funds set up in 2017 had management fees of 1% or less, and more than half of funds launched in 2017 had average management fees below 1.36%. Although averages may be deceiving because asset classes often have different fee rates, including lower fees for so-called founders’ shares, we foresee average hedge fund management fees falling 15% by 2025, to 1.16%. For stronger, consistent performers that have pedigree, fees may not fall.

The same trend can be observed in real estate funds, where more than 75% of funds launched in 2018 had management fees of 1.5% or less. Average management fees for all real estate funds were at 1.44% in 2017. We forecast that these management fees will slide a further 13.1% by 2025, to 1.25%. Private equity (PE) funds have been very resilient. Average fees stood at 1.86% in 2017, with 68% of funds launched at 2% or higher. In 2018, 59% of all PE funds launched stood at 2% or above. However, an in-depth analysis tells a different story. Large PE funds charge about 1.7%, because scale allows them to be more competitive, and small ones charge 2%. This is in line with the latest MJ Hudson analysis, which showed that although only 19% of funds in the 2018 sample were charging a management fee of 1.5%, the aggregate amount of capital targeted by these funds represented 59% of the capital targeted by the entire sample. We expect average fees on PE funds to fall 16.4% by 2025, to 1.55%.

The increased availability of alternative assets is also going to play a significant role in the decline in fees. Fee pressure will grow as active and passive mega-managers realise that AuM growth doesn’t necessarily translate into strong revenue growth and increased investor demand. Because of this realisation, managers will continue to turn to higher-margin products such as alternatives, increasing competitiveness in this space. And as the segment becomes more competitive, these mega-managers could try to leverage their scale and cost advantage by offering innovative and/or lower fees. This will result in the decline of overall fees in alternatives.

The alternatives segment has also been trying new models since the financial crisis. We are seeing a clear move towards outcome-based fees, such as higher performance fees for alpha-generating funds. Early-bird investors are also getting lower fees, and investors in multiple funds at the same company or with a large commitment often enjoy a volume discount. PE funds are offering a step-down in management fees after the initial investment period, and we’re also observing negotiations between limited partners and general partners affecting transaction fees. Clawback and similar clauses have remained a standard within alternatives.

Performance fees differ across asset classes. For hedge funds, they have, on average, drifted down from 20% closer to 15% for new funds being launched. The 20% performance fee or carried interest is still the norm in PE and real estate. We believe we’ll see lower management and performance fees or carried interest paid only for generation of alpha. Investors continue to appreciate both the funds’ alignment with their wants and needs and the crystallisation of carried interest on a distribution/cash basis, which has helped protect these fee levels.

Alternative asset managers still have to rethink their business models, adjusting their products, services and operations to ensure they not only survive, but thrive, as the industry changes. If alternative managers continue to provide alpha and differentiate themselves, we believe they’ll be able to keep fees steady, but will still be subject to business model pressures that require significant change.

Since the global financial crisis, regulators continue to introduce rules demanding that managers adhere to their fiduciary duty and provide value-for-money services to their clients. These regulations, along with industry pressures and increased transparency, have resulted in global total expense ratios (TERs)1 falling by 15.2% over the past five years – a faster decline than for management fees in the same period. We anticipate that as management fees continue their downward march and investors continue to move towards low-cost products, TERs will fall by more than 22%, to reach 0.53% by 2025.

Pressure on management fees has led to a decline in traditional managers’ ratio of revenue to AuM, and we project it will fall further, to reach 0.31% by 2025 – a decrease of 22.4% from 2017.

Despite this steep drop, the revenue pool of the traditional asset management industry will keep growing until 2025, reaching US$385.4bn, as traditional AuM soars to US$124.3tn.

Although the ratio of revenue to AuM already fell by 10.4% between 2012 and 2017, traditional managers did, on average, successfully decrease the ratio of costs to AuM by 14.2% in the same period, resulting in their operating margins increasing by 10.5%.2

Of the 64 managers whose annual reports we analysed, large and small traditional asset managers saw their operating margins rise by 10.5% and 15.6%, respectively. But midsized asset managers could only increase their margins by 3.5% between 2012 and 2017.3 The ratio of revenue to AuM declined most dramatically among midsized managers, dropping 23.6%, followed by large managers, at 10.1%. However, it’s important to note that managers with superior investment products fared much better, allowing them to make improvements in firm operations.

Managers have been able to compensate for the disparity between AuM growth and the decrease in contribution margin per AuM by streamlining operations and becoming more efficient. Those managers with scale have used their size to ensure they’ll continue to grow and keep their costs low. However, the question that looms is this: What will happen if there is a downturn?

Managers should use the current period of growth to ensure they are prepared for a decrease in both AuM and revenues. The following section outlines how PwC believes managers can ensure they are reaching investors’ objectives while remaining agile and keeping costs low.

Costs are increasing due to regulatory and reporting demands, while at the same time, pressures are forcing managers to prepare their future position. They’ll need to determine whether they’ll be niche or scale, which products are underperforming and should be reconsidered, and how they contribute to society overall.

In order to be fit for the future and able to adapt operations in a low revenue-to-AuM environment, we believe managers must focus on their current strategic position and plan for a future in which the majority of costs are variable and therefore easier to manage. It’s also important to evaluate how to scale through sourcing strategies.

Digital technology investments are helping managers innovate and serve investors by transforming many business functions. As managers look to integrate their front, middle and back offices onto one platform, the lines between these functions will blur. Data is becoming a core competency and strategy for managers, and those who are able to convert it into actionable insights will lead the industry.

As we’ve said, investing in digital technologies is critical to cutting costs and improving operations, and therefore margins. Managers with legacy systems need to become state-of-the-art and focus on implementing resources such as artificial intelligence (AI) and machine learning in the front office. Uncompetitive firms that haven’t invested in technology and have survived despite poor investment performance will find themselves orphaned with few, if any, strategic options.

Without good talent, you can’t transform or build for the future. New technologies are changing the skills that workers need, the way jobs and tasks are completed, and the very definition of talent. Managers are competing with each other, startups and established technology companies to attract talent and build the workforce of the future.

Building an AWM business with new talent requires a different way of hiring. Additionally, as a fresh generation of investors brings new expectations into the market, technical knowledge and financial experience will change. We have already seen this, as ESG investing has become more prominent and managers scramble to attract the best talent. New manager profiles are needed too, as alternatives, quantitative investing and smart beta increasingly become part of the investment landscape. And as firms turn to new technologies to mine data, people who are able to work with both the technologies and the analytics will become more important.

In 2025, we expect that humans will remain the dominant workforce, but technology will play a much stronger enhancement role than it does today, allowing the workforce to focus energy on core duties. According to the World Economic Forum’s Future of Jobs 2018 report, 56% of financial services companies surveyed are expecting to reduce their workforce due to automation. Given the advanced level of education in the industry, these displaced individuals could be redeployed to higher-value roles. As the competition for talent intensifies, redeployment or retraining of existing talent become viable options.

The AWM industry has long been considered traditional and hierarchical. As managers look to attract, train and develop talent, they will need to change both the public perception of the industry and their way of doing business. Managers need to think about themselves as technology companies, and not as in opposition to technology, to build a culture that will resonate with and attract the future workforce. This is increasingly important as managers are now missing out on a new wave of digital talent being lured by technology companies. New generations are no longer simply looking for a paycheck; they are searching for a company that reflects their values, rewards hard workers – not just vocal ones – and promotes a more even work–life balance.

Managers need to be thinking about upskilling current talent too. Transforming a business can be deeply unsettling for its people, and firms need to ensure they take their workforce on the journey with them. Business areas likely to be most affected include the following:

• Traditional analyst and research roles, which will be transformed by technology and data science
• Client relationship and engagement, due to increased digitisation of distribution channels
• Back- and middle-office functions, some of which can be automated for efficiency

According to PwC’s CEO survey, 29% of AWM CEOs are implementing continuous learning and development programmes, in part to attract and develop digital talent. This is lower than the global average of 42%. The AWM industry is behind the global average in all other aspects of workforce planning too, except for “implementing new, flexible ways of working” and “outsourcing to external providers.” This could be cause for concern, because it shows the industry’s lack of willingness to change and adapt. One example of a learning programme is PwC’s digital fitness tool, which allows firms to assess their employees’ capabilities and analyse and leverage the results to build a comprehensive digital talent strategy, with ongoing training to improve their digital acumen.